Elements of Salam in Islamic Banking:
There are 4 key elements in Salam:
- Cash Price, and,
- Purchased Commodity.
Background of Salam and How is it Halal?
Before prohibition of interest, farmers used to get interest based loans to harvest; and caravans for purchasing commodities. After prohibition of interest, they both were allowed to do Salam contract, to get money in advance.
Salam Contract as an Ancient Form of Forward Contract:
When Prophet Muhammad (Peace Be Upon Him) migrated from Makkah to Madinah, it was found that people are used to pay in advance for fruits and dates. Which are delivered within one, two, and three years’ time. But, such a sale was used to carry out without specifying the quality, measure, weight of commodity, or the time of delivery. So, the Prophet Muhammad (Peace Be Upon Him) ordained that:
“Whoever pays money in advance for fruit to be delivered later, should pay it for a known quality, specified measure, and weight of dates or fruit of course, along with the price and time of delivery”.
Comparison of Salam Contract with General Rules for Sale in Islam:
According to general Islamic Shariah rules, a sale must fulfill following three conditions. However, only the Salam and Istisna are exceptional from these conditions:
- Commodity for sale must exist;
- Seller should acquire ownership of that commodity; and;
- Commodity must be in physical or constructive possession of the seller
Applications of Salam in Islamic Banking:
Salam is basically a mode of finance for farmers and small traders. Salam in Islamic banking is used by micro banks and financial institutions, to support small industry. Salam contract is mostly used for:
- Agriculture financing;
- Working Capital Financing;
- Commercial and industrial financing;
- Export Financing; and;
- Operations and capital cost financing.
Understanding Parallel Salam:
After the execution of Salam agreement with one party, buyer or seller executes another Salam contract with third party. Parallel Salam contract is allowed with third party only. They must be two different and independent contracts, and these two contracts cannot be tied up.
Mechanism of Parallel Salam:
Let us understand it with the help of an example:
Bank purchases 500 Bags of Rice from “Ali” through Salam, with full prepayment and to be delivered on June-30th.
- “Ali” delivers 500 bags of rice to Bank on June-30th.
- Bank sells this commodity to a Third-Party, called “Company” on credit.
- After taking its delivery on an agreed date, Bank delivers it to “Company”.
- After taking delivery from Bank, the “Company” signs a promissory note against payment, on an agreed specified time.
Note: This lecture is a part of Islamic banking courses and Islamic finance courses, designed for the Islamic banking diploma and offered by AIMS UK, a UKRLP Registered and CPD Accredited Islamic finance institute.